2007 saw a substantial increase in foreclosure actions filed in Ohio, Kentucky, Indiana, and Michigan.  With this rise in foreclosures, questions arose on a number of issues impacting insurers, including how a foreclosure affects insurable interests.  This article addresses this issue as it relates to these four states.

A foreclosure is a lawsuit to obtain a judgment of foreclosure and the sale of the premises after default by the mortgagor.  A foreclosure lawsuit consists of a number of steps, culminating in a judicial order of sale of the property, followed by confirmation of the sale, and the possible entry of a deficiency judgment.  A foreclosure should be viewed as a process, and until the steps are completed, it cannot be said the property has been foreclosed.  The mortgagor may redeem the property within a time specified by statute by paying the amount of the judgment, plus costs and interest.

 “A person has an insurable interest in property whenever he would profit by or gain some advantage by its continued existence and suffer some loss or disadvantage by its destruction.”  CNH Capital v. Janson Excavating, Inc., 2007-Ohio-2127, citing Phillips v. Cincinnati Ins. Co. (1979), 60 Ohio St.2d 180, 181.  Accordingly, an insurable interest can exist even in the absence of title or deed to the property.


EFFECT OF FORECLOSURE ON INSURABLE INTEREST OF MORTGAGOR

Generally, a mortgagor retains an insurable interest even when in default of the mortgage loan, until the named insured’s right of redemption expires.

Ohio

R.C. 5721.25 governs rights of redemption in Ohio.  An Ohio court would likely recognize the insurable interest of a named insured during the pendency of a foreclosure action until such time as the court issues an entry confirming the foreclosure sale.  On rare occasions, a foreclosure sale may be vacated and the order of confirmation set aside keeping the insurable interest in the named insured as though no sale had been attempted.  Richland County Mut. Ins. Co. v. Sampson (1883), 38 Ohio St. 672.

Therefore, under Ohio law, a named insured may recover proceeds pursuant to all policy terms and conditions to the extent of his or her interest until the court enters an order confirming the sale.  An entry of confirmation of sale is not the same as an order directing a sheriff’s sale to occur at a later time.

Kentucky

A mortgagor has a twelve (12) month redemption period, during which time he has the right to redeem the property by paying the amount for which the property sold, plus interest.  A mortgagor’s insurable interest may continue beyond the redemption period until the purchaser has fully complied with his bid or executed a bond for its payment.  Smith v. National Union Fire Ins. Co. of Pittsburgh, 239 Ky. 106 (1931).

Indiana

A mortgagor may redeem the real estate prior to a sheriff’s sale by issuing payment to the county clerk prior to the issuance of the judgment and decree to the sheriff, or by payment to the sheriff directly after such issuance.  I.C. § 32-29-7-7.

Where a positive duty is imposed upon the mortgagor to insure for the benefit of the mortgagee and the mortgagor takes out such a policy, the mortgagee may acquire an equitable lien on the proceeds of any such policy in the event of a loss, whether or not the mortgagee is actually named as a loss payee.  Lakeshore Bank and Trust Co. v. United Farm Bureau Mut. Ins. Co., Inc., 474 N.E.2d 1024 (Ind. Ct. App. 1985).

Michigan

A mortgagor’s redemption period is six (6) months from the time the complaint is filed.  Mich. R.J.A. § 600.3115.  Courts have held a mortgagor’s valid assignment of a right to collect insurance proceeds to a third-party is of no value if the purchase price at foreclosure is equal to the full amount of the debt.  Emmons v. Lake States Ins. Co., 484 N.W. 2d 712 (Mich. App. 1992).

EFFECT OF FORECLOSURE UPON MORTGAGEE'S INSURABLE INTEREST

Most insurance policies now contain what is known as a standard mortgage clause wherein a named mortgagee’s right to recovery is not invalidated by act or default of the named insured, except under limited circumstances.

Ohio

Ohio courts recognize the named mortgagee as having a separate claim under the policy of insurance.  Pittsburgh National Bank v. Motorist Mutual Ins. Co. (1993), 87 Ohio App.3d 82.A mortgagee’s insurable interest will continue until the mortgage debt is fully satisfied by either recovery of insurance proceeds or foreclosure sale.

Therefore, when a property loss occurs prior to confirmation of the sheriff’s sale, the mortgagee has the option to: (1) recover from the insurance proceeds the full amount of the mortgage obligation, or amount due under the policy (if less); or (2) foreclose on the mortgage real estate and, to the extent the foreclosure sale does not satisfy the mortgage loan, recover the balance from the insurance proceeds.
For example, if the mortgagee elects to foreclose on the property and receives the full unpaid principal balance of the mortgage loan in a sheriff’s sale, we are of the opinion the court would find no insurance proceeds would be recoverable by the mortgagee.  This should remain true even if the mortgagee bids on and purchases the real estate in the foreclosure sale.

If the proceeds from the foreclosure sale or mortgagee’s bid on the property are less than the unpaid principal mortgage balance, the mortgagee may seek recovery of the remaining amounts due on the mortgage obligation from the available insurance proceeds.

Kentucky

Kentucky law provides for both an “open mortgage clause” and a “standard mortgage clause.” An “open mortgage clause” provides the policy shall be payable to the mortgagee as its interest may appear, and its rights will be defeated by a breach of the conditions of the policy by the mortgagor. Rhode Island Ins. Co. v. Wurtman, 98 S.W.2d 29, 31 (Ky. 1936). A “standard mortgage clause” provides in case of loss, the policy is payable to the mortgagee, and its interest as payee shall not be invalidated or affected by an act of the mortgagor. Grange Mut. Cas. Co. v. Central Trust, 774 S.W.2d 838, 839 (Ky.App 1989).

In a standard mortgage clause, the ability of the mortgagee to recover can hinge upon notification requirements. However, such requirements should be explicit as ambiguities are always resolved in favor of the insured. For example, in Anderson v. Kentucky Growers Insurance Co. Inc., 105 S.W.3d 462 (Ky. App. 2003) the court of appeals determined that had the insurer desired to make a mortgagee's recovery under the policy contingent upon notifying it of the filing of foreclosure proceedings, it could have done so by explicit language. Merely requiring notification of a “substantial change in risk” was insufficient to exclude coverage of the mortgagee when the mortgagee failed to provide notice upon the filing of foreclosure proceedings.

Indiana

The well-established rule is that where insurance is made payable to the mortgagee “as his interest may appear,” the mortgagee is entitled to the proceeds of the policy to the extent of his mortgage debt, holding any surplus after the extinguishment of his debt, for the benefit of the mortgagor.  Pearson, 408 N.E.2d 166.  The mortgagee’s interest is in the indebtedness, and not in the property.  Fifth Third Bank v. Indiana Ins. Co., 771 N.E.2d 1218 (Ind. Ct. Apps. 2002).  Both the property pledged and the insurance proceeds constitute a bank’s security for the debt, and a bank can proceed against either or both, e.g. through a foreclosure action and/or by asserting a claim to foreclosure proceeds.  Loving v. Ponderosa Systems, Inc.  479 N.E.2d 531 (Ind. Ct. App. 1985).  The rights of the mortgagee to the insurance proceeds are determined as of the time of loss, and as such, a foreclosure action brought after the loss does not necessarily affect the insurer’s liability to the mortgagee.  Fifth Third, 771 N.E.2d 1218.

A “standard mortgage clause” gives rise to an independent insurance contract between insurer and mortgagee.  Fed. Nat’l. Mortgage Assoc. v. Great American Ins. Co., 157 Ind. App. 347 (Ind. Ct. App. 1973).  That contract may provide that if the mortgagee acquires title to the property at the foreclosure sale, effectively reducing or paying off the debt owed, the insurer is obligated to compensate the mortgagee as the new owner, for a loss occurring after the sale.  Id.  If a policy contains a “loss payable clause,” the interest of the mortgagee decreases upon its acquisition of title following foreclosure, to the extent that the mortgagee is compensated for the mortgagor’s debt.  Id.              

Michigan

It is well settled under Michigan law that an insurance policy's standard mortgage clause constitutes a separate and distinct contract between a mortgagee and an insurance company for payment on the mortgage. Marketos v. American Employers Ins. Co., 240 Mich. App. 684, 692-693 (2000).

Furthermore, the standard mortgage clause requires an insurer to provide coverage for the mortgagee's interest in the insured property even if the mortgagee has acquired the fee title to the property through a foreclosure, regardless of the period of redemption. This is due to the fact that foreclosure of a mortgage resulting in acquisition of title by a mortgagee is generally regarded as an increase of interest rather than a "change of ownership" and does not require notice to the insurer under a standard mortgage clause. Cap Mort v. Mich. Basic Prop Ins., 111 Mich. App. 393 (1981).

One issue to note, however, is the foreclosure referenced in the agreement can only mean foreclosure by the mortgagee, since purchase of the property at foreclosure by anyone else would extinguish the mortgagee’s insurable interest. Id at 398.

CONCLUSION

When a covered property loss occurs prior to confirmation of a foreclosure sale, both the mortgagor and the mortgagee retain an insurable interest in the property.  After a court’s entry of confirmation of the foreclosure sale (or expiration of the redemption period), only the mortgagee retains an insurable interest, up to the unpaid principal balance of the mortgage loan, and subject to all applicable policy terms, conditions and limitations.

If the mortgagee receives money from a sheriff’s sale, or purchases the property for a specified bid amount in the sheriff’s sale, amounts due to the mortgagee under the policy of insurance would be offset by the amount received/bid by the mortgagee in the foreclosure.  If the foreclosure sale proceeds/bid equals the unpaid principal balance on the mortgage loan, the mortgagee is not entitled to recovery of additional insurance proceeds.

Reported decisions in these four states are relatively sparse, but as foreclosures continue to increase, courts will be forced to address these issues with increasing frequency.  We recommend consulting legal counsel should you have any questions regarding the application of these general principles to the specific facts of any claim.

On property losses involving a foreclosure, we recommend you consider investigating the following to determine if the foreclosure has an effect upon any amounts which would be due and owing to either the mortgagor (insured) or a named mortgagee:

1. When was the foreclosure action filed?
2. Who are the parties to the foreclosure action?
3. Has a sheriff’s sale been ordered and proper notice of the sale given?
4. Has the property been sold?  For what amount?  To whom?
5. What is the unpaid principal balance of the mortgage loan obligation (currently and on the loss date)?
6. Has a court of competent jurisdiction issued a final entry confirming the sheriff’s sale, or has the mortgagor’s statutory period of redemption otherwise expired?
7. Has the confirmation entry or sale been challenged, or is it likely to be challenged?

Is your company entitled to a setoff of amounts received/bid by the mortgagee after a sheriff’s sale?